1. Summary. Indonesia's inflation in February came as expected at
7.4% on a year-on-year (YoY) basis, after an unexpectedly large jump
in January. Bank Indonesia (BI) has maintained its reference
interest rate at 8% for the past four months. Indonesia's economy
grew at 6.3% in 2007, the fastest pace in a decade. Fitch Ratings
raised Indonesia's foreign and domestic currency debt ratings to two
levels below investment grade, citing the Government of Indonesia's
(GOI) continuous structural reform agenda and strong current account
position. During January-February, the GOI raised $2 billion from
global dollar-denominated bonds, and Rp 12.9 trillion ($1.4 billion)
from rupiah-denominated bonds. The GOI closed the State Asset
Management Company (PPA) on February 27. The Capital Market and
Non-Bank Financial Institution Supervision Agency (Bapepam-LK) and
the Securities and Exchange Organization of Iran (SEO) signed an
agreement to enhance bilateral cooperation. The Indonesian
Corruption Eradication Commission (KPK) named three central bank
officials as suspects in a bribery case. President Yudhoyono (SBY)
sent two names to the Parliament as candidates for BI Governor for
the next term, neither of them BI insiders. This cable uses and
exchange rate of 9,051 per dollar. End summary.

Unexpected Inflation Jump
-------------------------

2. The Central Bureau of Statistics (BPS) recorded a 1.8% (MoM)
rise in the consumer price index (CPI) in January, bringing annual
inflation to 7.4%, the highest rate since September 2006, when the
rate stood at 14.6%. BI claimed that the sharp increase was a
one-time shock, due to a rise in commodity prices. However, BI
subsequently increased its inflation forecast for 2008 to 6.0-6.5%,
up from around 5%. Coordinating Minister for Economic Affairs
Boediono stated that he is optimistic inflation will remain within
its 4-6% forecast this year. BI Governor Burhanuddin Abdullah and
Finance Minister Sri Mulyani announced that the GOI will focus on
inflation control. Mulyani noted, "The President wants all
food-related costs reduced." She added that the GOI has already
reduced import duties and taxes to help bring price increases under
control. The GOI announced a large policy package designed to
stabilize food prices on February 4 (ref B).

3. The CPI rose by 0.7% in February or 7.4% on a yearly basis, in
line with analysts' expectations after the January big jump.
Analysts note that rising global commodity prices and disruptions to
the transport of goods caused by floods and natural disasters in
some parts of the country continue to put pressure to food prices in
Indonesia.

4. Although aggressive U.S. rate cuts created some space for easing,
BI left its key interest rate unchanged for the fourth month at 8.0%
on March 6, as policymakers were wary of mounting price pressures.
The move was in line with analysts' expectations, following the
unexpectedly sharp rise in inflation in January.

6. On February 15, BPS announced that Indonesia's gross domestic
product (GDP) expanded 6.32% in 2007, the fastest pace in ten years,
as declining borrowing costs encouraged companies to invest and
consumers to spend. YoY growth for Q4 2007 was 6.25%, despite
floods, other natural disasters, world oil price hikes and the US
subprime mortgage crisis. Construction, transportation and
communications sectors contributed significantly to overall growth.
Record coal prices and surging income from sales of cocoa and
cooking oil have raised wages in those sectors, encouraging spending
on cars, motorbikes and mobile phones. Private consumption, which
represents about 70% of the economy, rose 5.6% in Q4, the fastest
pace in almost four years.

7. On February 14, Fitch Ratings raised Indonesia's foreign and
domestic currency debt ratings one notch from BBB- to BB, the
highest level since the 1997 Asian financial crisis. BB is two
levels below investment grade and one grade higher than Moody's
Indonesia rating, which is Ba3. The Fitch rating is on par with
Standard & Poor's, which rates the foreign currency debt at BB-/B
and domestic debt at BB+/B. Fitch cited the government's structural
reform agenda and strong non-oil and gas exports as reasons for the
upgrade. "The GOI's efforts to tackle corruption, bureaucratic and
regulatory hindrances to investments intensified in 2007 and were
complemented by key investment legislation as well as an economic
policy package specifically aimed at addressing main investor
concerns," says Ai Ling Ngiam, Director in Fitch's Sovereign Ratings
team. "Positive economic growth and balance of payments (BOP)
implications had already become evident in 2007, enabling Indonesia
to enter the current period of tightened global credit conditions
and weaker external demand on a firmer footing," added Ms. Ngiam.
The outlook is stable according to the agency's assessment.

8. The ratings hike surprised some analysts given the uncertainty
surrounding global economic trends. Fauzi Ichsan, a respected
economist with Standard Chartered, noted, "The upgrade would have
been more realistic and understandable in the second half of the
year when the global economic situation clarifies." However, Fitch
believes Indonesia will ride out a US slowdown better than its
regional peers because Indonesia's exports to the US account for
less than 5% of GDP, compared with more than 20% for Singapore,
Malaysia and Hong Kong. Only about 10% of Indonesia's exports to
China are components for US-bound products, compared with more than
50% for many other Asian nations. The Wall Street Journal also
pointed to Indonesian assets as a useful hedge against global
concerns, noting that a global slowdown will affect some areas of
the economy, resource stocks and producers of non-traded goods
should remain strong. David Fergusson, head of Indonesian research
at Citigroup Global Markets also opined in a recent report that
Indonesia is relatively immune to external shocks. Finance Minister
Sri Mulyani said the upgrade, "confirms our achievements to
strengthen our fiscal structure."

JAKARTA 00000515 003 OF 004

Bond Auctions Well Subscribed
-----------------------------

9. Indonesian bonds have attracted strong interest from foreign and
domestic investors because of their relatively high yields,
particularly following the recent cut in US interest rates. On
January 10, the GOI offered global bonds worth $2 billion,
attracting almost 200 orders from global institutional investor.
The offering consisted of $1 billion worth of 10-year bonds with a
coupon rate of 6.9%, and $1 billion worth of 30-year bonds with a
coupon rate of 7.75%. The GOI priced the global bonds to yield 3.1%
and 3.3% points over comparable US Treasuries, respectively. The
price was higher than 1.9% points over US debt for its 2007 30-year
bond sale and reflects the extent to which Asian markets have come
under pressure.

10. On January 22, the GOI raised Rp 2.3 trillion ($254.1 million)
from an auction of 15-year and 30-year treasury bonds, priced to
yield 10.55% and 10.8% respectively. The issuance follows an
auction of mid-term bonds launched on January 29 that raised a total
of Rp 3.7 trillion ($408.8 million). The mid-term bonds consisted
of two- and five-year zero coupon bonds, priced to yield 8.25% and
9.4% respectively.

11. At its February 12 auction, the GOI raised a total of Rp 1.05
trillion ($116 million), selling 5-year bonds at a 9.2% yield and
10-year bonds at an average yield of 10.1%. On February 19, the GOI
raised another Rp 5.85 trillion ($646.3 million) from auctioning
five- and ten-year zero coupon bonds priced to yield 9.55% and 8.6%
respectively. Without elaborating on the maturity of the debt to be
issued, a MOF official said the ministry expects to issue treasury
bills within the next two months and short-term debt regularly every
month. The government aims to raise Rp 91.6 trillion ($10.1
billion) from net bond issuances in 2008, the finance ministry said.

GOI Asset Sales above Target
----------------------------

12. Scheduled to sunset on February 27, 2009, the State Asset
Management Company (PPA) will cease operations September 2008 in
order to settle accounts by the final deadline. PPA is a successor
organization to the Indonesia Bank Restructuring Agency which
handled distressed assets after the financial crisis. PPA generated
Rp 1.57 trillion ($173.5 million) from asset sales in 2007, a figure
slightly higher than its target of Rp 1.5 trillion ($165.7 million).
According to PPA President Director Mohammad Syahrial, PPA posted a
pretax profit of Rp 71 billion ($7.8 million) last year, well over
its target of Rp 12.9 billion (1.4 million). Proceeds of the asset
divestments fund the state budget.

13. On January 28, the Capital Market and Non-Bank Financial
Institution Supervision Agency (Bapepam-LK) and the Securities and
Exchange Organization of Iran (SEO) signed an agreement to enhance
bilateral cooperation, particularly in enhancing Indonesia's shariah
stock market. The total market capitalization of Iran's shariah
market is $50 billion. Besides cooperating in the shariah sector,
the two countries plan to exchange training, information and
expertise in order to develop institutional capacity and better
regulate their capital markets.

Central Bank Scandals
---------------------

14. At its January 25 plenary meeting, the Indonesian Corruption
Eradication Commission (KPK) named BI governor Burhannuddin Abdullah
along with BI Legal Affairs Director Oey Hoey Tiong and BI Surabaya
office Director Rusli Simanjuntak as suspects in a bribery case.
Indonesian authorities detained Tiong and Simanjuntak in
mid-February and banned 15 other BI officials from international
travel until further notice, according to media reports. The KPK
alleges that BI officials paid Rp 31 billion ($3.4 million) in
bribes to legislators and law enforcement officials in 2003 and

JAKARTA 00000515 004 OF 004

2004. According to the KPK, BI disbursed Rp 96.25 billion or $10.5
million ($7.5 million from the Indonesian Banking Development
Foundation and $3 million from the BI budget) to lawmakers to
resolve BI officials legal problems related to the misuse of Bank
Indonesia Liquidity Assistance (BLBI) funds and to pass banking
legislation. BLBI refers to the emergency liquidity credits
extended by Bank Indonesia to commercial banks during the 1997-98
financial crisis.

Candidates for New BI Governor
------------------------------

15. On February 15, President Yudhoyono (SBY) sent two nominations
for BI Governor to the Parliament, neither of whom is a BI insider.
The candidates are Bank Mandiri's Chief Executive Agus Martowardojo
and the deputy director of state asset company PT Perusahaan
Pengelola Aset (PPA) Raden Pardede. A committee in Parliament
rejected the candidates in mid-March and the recommendation will go
to Plenary. The current five-year term of Governor Burhanuddin
Abdullah ends by May 17. SBY may have to choose another candidate
if the Plenary decides against the nominees.

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